The Federal Reserve is expected to raise interest rates on Dec. 19 for the fourth time this year, but the central bank may signal a less aggressive path as it heads into 2019.
The potentially dovish outlook would come amid signs that growth may slow next year, partly due to trade uncertainty and to the boost from fiscal stimulus wearing off. It also would follow a recent softening in inflation data, which analysts say takes pressure off the Fed as it continues to gradually tighten monetary policy.
The rate hike would put the federal funds rate at a target range of 2.25% to 2.5% and mark the central bank's ninth increase since the financial crisis.
Fed officials penciled three more rate hikes for 2019 in their September quarterly projections. That may still be the case in the new round of forecasts, but some analysts say the central bank may now shift the outlook for 2019 to two hikes.
"It will be increasingly difficult to justify additional rate increases next year in the face of a more dismal reality of waning inflation and slower growth," Lindsey Piegza, chief economist at Stifel, wrote in a note to clients.
The Fed's preferred inflation gauge was below its 2% target in October for the third month in a row, with the core personal consumption expenditures index rising 1.8% year over year.
That is despite a U.S. unemployment rate of 3.7%, the lowest since 1969. Inflation "doesn't appear to be accelerating" above the Fed's 2% goal anytime soon, said Nationwide Mutual Chief Economist David Berson, noting that Fed officials are forecasting a benign outlook for inflation in the next few years even as the labor market keeps strengthening.
The U.S. economy is also continuing to grow above trend levels, with GDP rising 3.5% in the third quarter, down from the 4.2% rate in the second quarter. But economists are forecasting that growth will slow globally in 2019, a development they say the U.S. economy will not be immune to.
Analysts will be watching for any changes in the Federal Open Market Committee's post-meeting statement. One potential adjustment includes the removal of a phrase that currently says "further gradual increases" in interest rates may be necessary. If they do remove that phrase, Fed officials will emphasize that they are moving to a more data-dependent approach, where policy is not on a preset course and decisions are based closely off incoming economic data rather than more traditional long-term forecasts. The FOMC hinted at the possible change in the minutes of its November meeting.
Fed Chairman Jerome Powell will face a tricky balancing act at his news conference, where the "key words will be caution, patience, risks and data dependence," wrote Michelle Meyer, head of U.S. economics at Bank of America Merrill Lynch. But at the same time, she added, he will likely avoid sounding too concerned about economic risks and will continue to highlight the underlying strength of the U.S. economy.
"Delivering a hike but with a clear message that subsequent hikes will be purely data-dependent will, we think, be the best approach," she wrote.
Powell may expand on his recent comments on how close the Fed is to the neutral rate of interest, a theoretical rate where the Fed would be neither giving the economy an extra push nor holding it back.
The Fed chief said Nov. 28 that its benchmark rate was "just below the broad range of estimates" that Fed officials view as neutral, immediately leading to a stock market spike as investors believed the Fed was closer to halting its rate increases. But analysts said that was an overreaction and noted that most Fed officials still see some room to keep raising rates, given that their estimates of the neutral rate range from 2.5% to 3.5%; the median view is 3.0%.
Futures markets suggest that investors are pricing in a dovish Fed next year, and economists have also been scaling back their outlook for Fed rate increases. That includes the forecasting firm Monetary Policy Analytics, led by former Fed Governor Larry Meyer, which now sees the Fed raising rates twice in 2019 instead of three times.
But Derek Tang, an analyst at the firm, says it is "certainly possible" that economic data may come in stronger next year and lead to more rate hikes.
"That's why Powell is keeping his options open," Tang said. "[He] will be very careful not to box himself in and eliminate his options."